This paper explores the rationale for unemployment benefits as a complement to optimal non-linear income taxation. High-skilled workers and low-skilled workers face different exogenous risks of being unemployed. As long as the low-skilled workers face a higher unemployment risk, we find that there is a case for over-insuring the low-skilled, hence the unemployment benefits of the low-skilled should be higher than the pure insurance purpose would prescribe. This effect is likely to prevail in a model with a more realistic treatment of the labor market.
Optimal non-linear income taxation unemployment benefits